Fed could become worried about Puerto Rico

Surrounded by a sea of economic news, the Commonwealth of Puerto Rico got a couple lonely mentions in the minutes from the Federal Reserve’s last policy meeting. It suggests that if nothing else, the financially strapped island is on the central bank’s radar as a potential financial concern.

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Seven Seas Beach near Fajardo, Puerto Rico

Puerto Rico has been battling back legacy costs and working to improve its lagging economy, but last summer the island had lost the confidence of many in the municipal bond market, where it goes to finance its debt. Those $70 billion in bonds are exempt from federal, state, and local taxes, and thus widely held by muni bond funds in the continental U.S.

The Fed’s key reference in the minutes from its January meeting comes amid a discussion about “financial developments” in the period between meetings. It’s wedged between two mentions of emerging markets (the island is a Commonwealth of the U.S.). Here is the quote:

“Recent volatility in emerging markets appeared to have had only a limited effect to date on U.S. financial markets. Nevertheless, participants agreed that a number of developments in financial markets needed to be watched carefully, including the financing situation of the Puerto Rican government and particularly the unfolding events in emerging markets.” (page 13-14)

The other reference to Puerto Rico mentions it as an exception to the otherwise “stable” municipal bond market (page 12).

In an unrelated, yet interesting coincidence, the New York Federal Reserve Bank published some research on Puerto Rico on its Liberty Street Economics blog last week that suggests the island’s economy may not be as bad as many think (though still bad). Jason Bram, a researcher in the New York Fed’s research and statistics group, wrote:

“While Puerto Rico’s labor market appears to not have been as weak in 2013 as the currently reported employment data suggest, it nonetheless remains depressed; it remains to be seen if the preliminary signs of softness in late 2013 are a harbinger for the economy’s outlook in 2014.”

The reference in the minutes drew some notice (and apparent wails) on Twitter: